Cheap Money May Cost Discount Brokers

Ameritrade's Potential Damage

On average, Ameritrade clients held a whopping $5.7 billion a day in cash in the last fiscal year, which ended Sept. 30. Ameritrade earned $185 million in fees from a partner that reinvested the cash at higher rates. (The partner is TD Bank USA, a subsidiary of Toronto-Dominion Bank(TD Quote), which owns about 45% of Ameritrade stock.)

Now, here's the troubling part. That $185 million accounted for 10% of Ameritrade revenue for the 2006 fiscal year. Even more ominous, it works out to 21% of the company's $526.7 million in net income for 2006, if you adjust the $185 million down by the company's 38.5% tax rate.

Ameritrade expects to earn even more off of cheap funds this year. The brokerage has told analysts that the profits on sweep account cash will reach $515 million or more in fiscal 2007, in part because it will transfer even more brokerage account cash to TD Bank USA.

That profit growth is crucial, because Ameritrade needs the earnings to fund an aggressive share buyback that investors expect. Ameritrade has about 20 million shares left to go in a 32 million-share repurchase program authorized by the board. So if clients pulled the plug on the cheap loans to Ameritrade, the brokerage's stock could suffer a double whammy.

E*Trade's Potential Damage

Because Ameritrade gets a fee from TD Bank USA for the brokerage account cash, it's easy to see in the financials what Ameritrade makes off the deal.

E*Trade and Schwab reinvest the money internally, so it's harder to break out exactly what they make on the spread. An easier way to assess the potential damage is to look at how much each company's cost of funding would go up if clients demanded better returns, says Allen Puwalski, the head of financial sector analysis at the Center for Financial Research and Analysis, an accounting research firm that has been tracking the issue.